"Legal Rights to Assets in Case of Bankruptcy"
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One big advantage of loaning an entity some money through a fixed income security debt obligation such as a bond, is that they have the legal duty to pay you back.
Of course, not everybody who owes money does pay it back. Fortunately, businesses and (most) governments do intend to pay it back (unlike some individuals), and make a good faith effort to do so. Yet we know that is not always enough.
Sometimes they run into financial problems.
Since You've Made a Legal Loan to Someone, You Have Legal Rights
This is in regard to the borrower stops making payments.
You are in line to profit from any legal action regarding a bankruptcy or insolvency -- just as your mortgage company has the protection of foreclosing on your house if you stop making your mortgage payments.
Of course, when you loan your money, you hope to get it back without any fuss or hassle, just as the mortgage company doesn't want to foreclose on anybody's house. But it can and does happen.
Stock Owners Don't Have the Legal Rights Fixed Income Investors Do
In contrast, if you buy shares of stocks, you are an owner of the company and if the company goes into bankruptcy you have no legal claim to any of its assets
Now, it's true that when a company goes into bankruptcy, a sizable amount of money is going to go to the lawyers on all sides. Still, companies have assets -- from office buildings to fork lift trucks -- and if they continue to operate under a court's supervision to turn the business around, you as a creditor to the company are eligible for some amount of the money they owe.
If a company is liquidated, meaning that all assets are sold off to the highest bidder, you'll get your proportionate share of the proceeds.
You may not get $1 back for every dollar owed to you -- but you have the legal right to something.
Yet Investing in Fixed Income Assets for the Worst Case Seems Wrong
Personally, I think there are other -- and much better -- ways of reducing the risk of your investments going wrong.
For one thing, don't buy individual bonds (or stocks) to begin with, and then you don't have to worry about that particular company going out of business. Small investors should protect themselves by diversifying.
There're simple and easy ways to profit from many bonds and stocks, so you don't put all or most of your eggs in one basket.
You don't want to be involved in a company bankruptcy whether it's reorganizing its finances or going totally out of business. Whatever you get at the end is likely to be very small, and it will take years.
And you may not even get your legal rights. It's my understanding that when the United States federal government essentially took over General Motors, that GM bondholders got shafted. The United Autoworkers got a better deal than the people who'd trusted GM with their investment money.
So, to my mind, this legal right of fixed income assets is mostly an illusion. It exists, but it's hardly worth considering when you're planning your retirement portfolio.
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